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AM Co will receive a perpetuity starting in 2 years time of $10,000 per year, increasing by the rate of inflation which is 2%.
What is the present value of this perpetuity assuming a money cost of capital of 10.2%.Dear Tutor,
I have read the answer in BBP practice book and the answer for above question is $115,740
After got the real rate of 8% , they then said the perpetuity factor from T2= (1/r)-DF1= (1/0.08)-0.926=11.574My question is why taking the DF1 only? Shouldn’t it be DF2 which is 0.826? I mean the question also said the perpetuity start in 2 years time. Why the answer only subtract the DF for 1 year only?
Thank you
The flows are from time 2 to infinity.
The discount factor for a perpetuity (1/r) gives the PV from flows from time 1 to infinity, so subtracting the 1 year discount factor gives the factor for 2 to infinity.
Our free Paper MA lectures on discounting will help you with this (because this part is revision from Paper MA).
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